CPAs performing litigation support must be careful not to inadvertently waive privilege.

ATTORNEY-CLIENT PRIVILEGE
EXTENDS to accountants under
the Kovel rule when a CPA acts at
the direction of the lawyer to provide
information for the client. Inadvertent
disclosure of confidential information may
lead to loss of the privilege.

A PRACTITIONER WHO DOES
LITIGATION CONSULTING should
document the circumstances of his or her
hiring, log relevant phone calls and
appointments, obtain an engagement
letter from the lawyer, label the
project’s work product confidential,
properly conduct client meetings,
directly invoice the attorney (not the
client), send reports directly to the
lawyer and make sure engagement report
materials are segregated from other work
files.

COLLABORATING CPAs AND
ATTORNEYS SHOULD obtain
client consent to communicate their
business using cordless or cell phones
and take precautions to ensure use of
electronic communications tools such as
cell phones and faxes doesn’t cause
confidentiality to be waived.

SCRAMBLERS AND ENCRYPTION
TOOLS can substantially
reduce the likelihood of waiver of
privilege due to inadvertent disclosure
but can be expensive ways to foil
interception.

A CPA SHOULD BE AWARE
that for work involving a
corporation it is preferable that
outside counsel rather than in-house
counsel hire the CPA. If outside counsel
cannot engage the accountant, in-house
counsel is preferable to corporate
management. The probability of a
successful claim of privilege is
diminished when management hires the
CPA.

IF A CLIENT’S LOSS OF A
CASE turns on the inadvertent
disclosure of an electronic
communication, the attorney and/or
accountant could be sued for malpractice
or subject to disciplinary proceedings.

CARL.
PACINI, CPA, JD, PhD, is associate
professor, accounting and business law, at
Florida Gulf Coast University, Fort Myers,
Florida, and adjunct professor of forensic
accounting at Florida Atlantic University,
Boca Raton; he is a member of the Florida
Bar. WILLIAM HILLISON, CPA, PhD, CMA, is
Andersen Professor of Accounting and
Information Systems at Florida State
University, Tallahassee; he has been
published in many professional and
academic journals. M. G. FENNEMA, CPA,
PhD, is associate professor of accounting
and the department chairperson at Florida
State University, Tallahassee. RAYMOND
PLACID, CPA, JD, is visiting professor of
accounting and business law at Florida
Gulf Coast University, Fort Myers. The
authors’ e-mail addresses are,
respectively,
cpacini@fgcu.edu , bhillis@cob.fsu.edu
, bfennem@cob.fsu.edu
and rplacid@fgcu.edu
.

n a landmark case Louis Kovel, a
former IRS agent and accountant, had been hired by
a law firm to help advise its clients. Kovel met
with and received information from a client under
IRS investigation for tax fraud. When subpoenaed
by a grand jury, Kovel refused to answer questions
about the client and was sentenced to a year in
prison for contempt of court. The Second Circuit
Court of Appeals reversed the contempt citation.
It ruled there was no reason in the case to
exclude accountants from the list of those who
assist lawyers in providing legal services (
United States v. Kovel ).

As
Kovel established, CPA-client
communications may be privileged under a specific
set of conditions. Not meeting them can result in
loss of privilege—and can cause a legal strategy
to fail. Today’s technology such as e-mail, voice
mail, cell phones and faxes makes those conditions
difficult to maintain. This article will discuss
the framework in which attorney-client privilege
extends to accountants and will suggest practical
ways CPAs operating in a technological environment
can avoid inadvertent disclosure of confidential
information to preserve attorney-client privilege.

SOME BACKGROUND ON PRIVILEGE Although some states have statutes
to protect the communication between
accountants and clients in limited
circumstances, such privilege isn’t
recognized under federal common law and is
of little value in federal cases (
Couch v. United States
). Moreover, the CPA-client privilege
established by IRC section 7525 applies
only to tax advice in noncriminal matters
before the IRS and noncriminal tax
proceedings in federal court. For federal
proceedings communications between a
client and a third party such as a CPA may
be privileged when an attorney retains
that agent (see “Third-Party Privilege”).

Subpoenaed
by a grand jury, a former IRS
agent and accountant refused
to answer questions about his
client and was sentenced to a
year in prison for contempt of
court. The Second Circuit
Court of Appeals reversed the
contempt citation.

Proposed rule of evidence 503 (also known as
Supreme Court standard 503) established the
general scope of the attorney-client privilege
under federal common law: “A client has a
privilege to refuse to disclose and to prevent any
other person from disclosing confidential
communications made for the purpose of
facilitating the rendition of professional
services to the client.” The communications can be

Between the client or client’s
representative and his attorney or the attorney’s
representative.

Between the client’s attorney and
that attorney’s representative.

From the client or his or her
lawyer to a lawyer representing another
person or organization in a matter of
common interest. (For example, in a joint
defense where multiple parties share a
common legal interest, confidentiality
extends to communications between them and
their attorneys or agents.)

Business-organization clients may
assert attorney-client privilege as individuals
do, but applying privilege to corporate
situations, even those involving in-house counsel,
can be problematic because corporations act only
through their agents. The Supreme Court ruled that
a communication is privileged when management
authorizes an employee or former employee to speak
with an attorney (or agent thereof) regarding
conduct or proposed conduct related to employment
( Upjohn v. United States ).
Formal criteria for all situations involving a
corporate setting and the attorney-client
privilege that applies don’t exist, however. Prior
to meeting with or communicating with clients,
CPAs who perform litigation support should obtain
a letter that clarifies their role as agents of
the lawyer.

WAIVER STANDARDS FOR INADVERTENT
DISCLOSURE An attorney’s client holds the
attorney-client privilege and has the power to
waive it. In practice the client’s lawyer also has
limited authority to waive it; by extension a CPA
agent can cause its forfeiture. Some courts have
held that any disclosure—even an accidental
one—waives confidentiality. Disclosure can occur
through the use of electronic communications
devices such as cordless and cell phones, faxes
and e-mail. It can result from unintentionally
faxing a document to an opposing attorney or
sophisticated espionage methods by adversaries.
Cases involving inadvertent disclosure are subject
to three different court approaches.

The strict responsibility approach.
Courts that follow this approach
treat all inadvertent disclosure as a waiver of
privilege and do not require the element of
intent. They reason that once a third party
obtains a privileged communication,
confidentiality is lost and cannot be restored.
(Some courts insist disclosure is evidence of the
client’s intention to forfeit privilege.) This
thesis is simple for courts to administer and
yields predictable results. If an attorney and his
or her agents do not want an adversary to use
confidential information, they must safeguard it
sufficiently. The seminal case for this approach
is Underwater Storage, Inc. v. United
States Rubber Co.

Critics of this
rule say it undermines the confidence parties can
place in attorney-client privilege, provoking
client reticence and reducing a lawyer’s ability
to provide effective representation. It also
punishes a client for someone else’s error. For
example, if a consulting CPA’s secretary
accidentally presses the wrong speed-dial button,
a client’s case can be damaged.

Third-Party Privilege W hen ruling on whether
attorney-client privilege extends to a
lawyer’s third-party agent such as a CPA,
courts make subtle distinctions aimed at
preventing the abuse of privilege. For
example, one court ruled communications
between client and accountant prior to the
attorney’s hiring the CPA are not
privileged ( United States v.
Cote ). However, privilege
applied when the client retained a lawyer
who then hired a CPA, or the client
consulted with the attorney and accountant
simultaneously.

In another example an
attorney directed a client to consult
with an accountant regarding that
client’s conviction for willful failure
to file a federal income tax return. On
appeal the Ninth Circuit refused to
extend privilege to the accountant
because there was insufficient evidence
to show the lawyer had commissioned CPA
services to support the rendering of
legal advice ( United States v.
Gurtner ). Thus, if a
practitioner provides business advice
rather than litigation-related
information for the attorney, no
privilege attaches. Even
litigation-specific information is
unprivileged if it is incidental to
business advice.

This limitation
was reinforced in the Sequa Corp. case,
in which in-house counsel hired Arthur
Andersen, the corporation’s auditor, to
prepare a memorandum of the tax
consequences of a proposed corporate
reorganization. After discussions
between Sequa and Andersen, the firm
delivered the final memorandum to
in-house counsel. Sequa consummated the
transaction as Andersen recommended.

Later, the IRS subpoenaed Andersen
to produce the memo. In response Sequa
claimed attorney-client privilege,
saying the Andersen memorandum had been
prepared to aid in-house counsel in
rendering legal services. The Second
Circuit held the Kovel rule did
not apply because Sequa consulted the
accounting firm for tax advice rather
than for assistance with and support of
legal services. The court noted Sequa
had not produced documentation such as a
separate retainer agreement or itemized
billings for the Andersen report to
support a claim of privilege (
United States v. Adlman
).

The Eighth Circuit Court
of Appeals ruled that in applying
Kovel it is inappropriate to
distinguish between those on the
client’s payroll and independent
contractors such as CPAs. In the example
of In re Bieter Co. the court
set out principles applicable to
determining whether privilege protected
third-party communications. It said

The communication must be
made for the purpose of seeking legal
advice. The third-party expert
that’s involved must act at the
direction of the client. The subject matter of the
communication must be within the scope
of the consultant’s duties. The communication must not
be disseminated beyond those parties who
need to know.

The modern or “no waiver” approach.
Under this approach the privilege is
waived only when a disclosing party chooses to do
so. An accidental fax transmission, for example,
would not waive privilege. The court need
determine only whether the disclosed material is
protected by attorney-client privilege; if it is,
the recipient may not introduce it at trial.
Supporters say a waiver is, by definition,
intentional relinquishment of a known right,
making the concept of an “inadvertent waiver”
inherently contradictory. The seminal case for
this approach is Mendenhall v.
Barber-Greene Co.

Critics of
this approach claim it is too difficult to discern
a client’s intent and that clients can change
their minds and lie. Critics also say the “no
waiver” approach erodes incentives for attorneys
and their agents to protect clients’ confidential
documents.

The balancing test approach.
Most state and federal courts use
this approach, which evaluates whether privilege
has been waived based on the circumstances of a
disclosure. Courts using this approach often apply
the following five-factor checklist, which
originated with Lois Sportswear, USA, Inc.
v. Levi Strauss & Co .:

The reasonableness of the precautions
taken to prevent inadvertent disclosure.

The number of inadvertent
disclosures.

The extent of the disclosure.

Any delay in measures taken to
rectify the disclosures.

Whether the overriding interests of
justice would or would not be served by relieving
a party of its error.

The balancing test
is more work to apply, but what it lacks in ease
of application it makes up for in fairness.
However, critics say it leads to inconsistent
results because each court will define “reasonable
precautions” differently, encouraging parties to
litigate unnecessarily.

SAFEGUARDING E-COMMUNICATIONS Privileged information is susceptible to
waiver by interception or inadvertent disclosure
in electronic communications. A basic component of
the law covering attorney-client privilege is that
a protected communication must have a reasonable
expectation of privacy. Collaborating attorneys
and CPAs should take care that their use of
electronic communications tools such as cell
phones and faxes doesn’t cause confidentiality to
be waived. In particular, electronic
communications carry unique risks.

Telephones. Generally, a
conversation on a landline phone between an
attorney and client or an attorney and a CPA
expert is privileged. In United States v. Hall,
the court held that when a person talks by
landline telephone, he or she can reasonably
assume privacy. That is, traditional phone
conversations take place under circumstances
considered inherently confidential. The law is
less clear about cordless and cell phones.

A federal appeals court said a client’s
cordless phone conversation with his attorney was
not protected in United States v.
Mathias. Other courts have ruled that
no reasonable expectation of privacy exists for
cordless phone conversations because users
broadcast their messages in the same way that
radio stations do ( State v. Smit
h). This principle of law is subject to
challenge, however, as communications technology
evolves.

Cell phones also broadcast
messages using radio signals, but not at standard
FM frequencies. They still can be intercepted with
illegal scanning devices. This fact has led some
courts to hold that a cell phone user lacks a
reasonable expectation of privacy ( Salmon
v. State ).

Presumption of
privacy more likely depends on the specific
technology used to protect communications. Since
such technology continues to change, courts
probably will avoid hard and fast rules in this
area. Communication of privileged information to
an unknown third party via eavesdropping or
inadvertent disclosure continues to be a risk.
Accordingly, CPAs should exercise extreme caution
in communicating confidential material over
cordless or cell phones. New York, Iowa and
Illinois bar associations have released ethics
opinions stating that attorneys should warn
clients that all cell phone conversations are not
secure. Both attorneys and CPAs hired by attorneys
should obtain client consent to communicate their
business using cordless or cell phones—or they
should refrain from discussing client-specific
business on them.

There is technology to
enhance confidentiality. For example, one device
will “scramble” cordless or cell phone
communications at a cost of several hundred
dollars per scrambler.

Fax machines. In general a
fax communication is protected by the
attorney-client Kovel privilege (see United
States Fidelity & Trust Co. v.
Canady ). Faxes differ from cordless
and cell phone communications because the machines
use landline telephone technology for
transmission, eliminating the interception
possibility associated with radio waves. Despite
possible misdirection of a fax transmission, a
reasonable expectation of privacy still is
afforded this medium.

CPAs can safeguard
faxes with a cover sheet stating the information
in it is privileged. It might say the following:

Privileged and confidential: All information
transmitted hereby is intended only for the use
of the addressee(s) named above. If the reader
of this message is not the intended recipient or
the employee or agent responsible for delivering
the message to the intended recipient(s), please
note that any distribution or copying of this
communication is strictly prohibited. Anyone who
receives this communication in error should
notify us immediately by telephone and return
the original message to us at the above address
via the U.S. mail.

The legal effect
of the confidentiality legend depends on which of
the three waiver theories a court follows. A
legend will have no impact on a court that adheres
to the strict responsibility approach, but a court
that subscribes to the “no waiver” approach may
not even require a legend to put opposing counsel
on notice. A court that follows the balancing
approach probably would consider the legend a
reasonable precaution.

E-mail. Communication by
e-mail also is a gray area of the law. The private
internal e-mail systems used by accounting and law
firms do not create the potential for inadvertent
waiver of the Kovel privilege. Nonprivate
e-mail systems, on the other hand, evoke questions
about whether such communications carry a
reasonable expectation of privacy.

In a
lawsuit challenging the Communications Decency
Act, a federal district court ruled that
unencrypted e-mail is not secure ( American
Civil Liberties Union v. Reno ).
However, in a case involving America Online (AOL)
e-mail transmissions, a federal appellate court
held that the sender of an e-mail message had a
reasonable expectation of privacy ( United
States v. Maxwell ). AOL e-mail
messages are afforded more privacy than messages
on other Internet-access providers because AOL
privately stores them for retrieval in its
centralized, privately owned computer. Use of an
Internet service provider such as AOL, in which
access to e-mail communications is protected by a
password, is supportable as due care.

E-mail is vulnerable to both interception and
inadvertent disclosure. One common method to
enhance the confidentiality of e-mail
communications and the probability of a successful
claim of Kovel privilege is encryption,
which can make a plain-text message unreadable by
processing it with a mathematical algorithm. The
use of encryption can substantially reduce the
likelihood of waiver of privilege due to
inadvertent disclosure, but it can be an expensive
way to foil interception.

HOW CPAs CAN PLAY IT SAFE
Case law shows that procedural
safeguards help preserve attorney-client privilege
and its extension to CPAs under Kovel . A
practitioner who does litigation consulting should
document the circumstances of his or her hiring,
obtain an engagement letter from the lawyer, label
the project’s work product “confidential,”
properly conduct client meetings, directly invoice
the attorney (not the client), send reports
directly to the lawyer and make sure engagement
report materials are segregated from other work
files.

Document the hiring process.
Whether the attorney calls you, an
associate suggests you call or the subject comes
up at a professional luncheon, document your
participation in the legal matter as of the first
conversation about it. Log relevant phone calls
and appointments.

Be aware that at a
corporation, outside counsel rather than in-house
counsel should hire the CPA. If outside counsel
cannot hire the CPA, in-house counsel rather than
corporate management should engage the accountant.
The probability of a successful claim of privilege
is diminished when corporate management hires the
CPA.

An attorney generally should not hire
the client’s existing CPA; doing so can make it
difficult to establish the practitioner has
advised in the context of litigation rather than
business. If counsel hires a client’s accountant,
matters covered by the privilege should be
segregated to demonstrate the engagement was not
part of any other services performed by the
practitioner. If you are the CPA and work for a
firm, recommend a colleague handle the litigation
work. The firm then can erect a “Chinese wall”
between the regular and the investigative
accountants and their respective files.

Ask the attorney to issue the
engagement letter. Be
sure the attorney provides you with a
written agreement that defines precisely
the terms of the arrangement and describes
the legal purpose of the accounting
services. If appropriate, this letter
should state that you are being hired in
anticipation of litigation. Check the
letter to make sure it has covered several
important points, which follow.

The
engagement agreement should state that
all communications between the attorney,
client and accountant are incidental to
rendering legal services and are
intended to remain confidential; that
you (the CPA) and client may communicate
outside the attorney’s presence as long
as you do so at counsel’s direction;
that none of the parties should disclose
the nature or content of any
communications or work product to any
third party, including government
officials, or privilege likely will be
waived; that all documents including
workpapers for the engagement are the
property of the lawyer and are held by
you solely for the attorney’s
convenience, and that once your work is
done, you will deliver all related files
to the lawyer and will not retain
copies.

If an engagement
agreement isn’t used, the lawyer should
use a “Kovel letter,” which is
less formal. It should say the lawyer is
retaining you to assist in his or her
work for the client. A Kovel
letter generally specifies the CPA
will bill the attorney directly and that
the project workpapers are the property
of the attorney. It should instruct the
accountant about the specific tasks to
be performed and to maintain the
confidentiality of all information
received or generated.

PRACTICAL
TIPS TO REMEMBER

If challenged in court, the
attorney-client privilege
extended to CPAs under the
Kovel rule must be
proved valid. A carelessly
structured arrangement leaves
the privilege susceptible to
challenge.

A CPA hired by an
attorney to obtain facts for a
client’s case should get a
written engagement agreement
that precisely states the
terms of the arrangement. The
letter should state that all
communications among the
attorney, client and
accountant are to remain
confidential and that all CPA
workpapers are the attorney’s
property.

The CPA should
label work product
confidential, document client
meetings, directly invoice the
attorney, send reports
directly to the lawyer and
segregate litigation-related
report materials from other
client work product, if any.

CPAs should
mitigate the risk of
inadvertent disclosure and
eavesdropping from the use of
electronic communications by
minimizing use of cordless or
cell phones to discuss
privileged information.

Fax privileged
material with a cover sheet
bearing a confidentiality
legend (above). It offers some
protection if a communication
goes to the wrong person by
mistake.

Use a methodology
for preparing an investigative
or litigation-related report
to make it distinct from other
work product, particularly if
in the ordinary course of
business you generate reports
that look similar. However,
the litigation report must be
conventional enough that it
doesn’t invite a challenge for
failure to follow “acceptable”
methods, and the methodology
for each relevant transaction
must be the same.

Label confidential CPA work product.
Demonstrate your work product is
protected by writing or typing “confidential” on
such documents and by restricting circulation only
to necessary persons. In Large v. Our
Lady of Mercy Med. Ctr., the court found
that merely tagging work product with a Post-it
note was not an adequate protection. Work product
marked as confidential should contain genuinely
confidential information; “confidential” should
not be routinely placed on your entire work
product. Labeling truly confidential documents as
such demonstrates the intent to keep them
separate. Some CPAs keep a record of confidential
documents in a privilege log. Any written work
product should say it is being produced at the
attorney’s request.

Conduct meetings properly.
For meetings involving you, client
representatives and/or the attorney, take minutes
noting the date, who is present, the subject and
legal reason for the meeting and the
confidentiality of the proceedings. It’s important
to state the legal purpose; a court may ask
whether the meeting would have been held if
litigation had never been a prospect. If the
answer is “yes,” the meeting likely will be viewed
as having a business purpose. Be aware that in a
corporation, only employees with essential
information should be in attendance.

Invoice the law firm. Bill
the law firm for whom the work is being done.
Don’t send invoices or copies of invoices to the
law firm’s client. The law firm, not the client,
should pay the CPA. In the event counsel hires you
and you are the client’s current CPA, you should
bill litigation-support services separately from
other accounting and tax services ( United
States v. Adlman ).

FORENSIC AND
LITIGATION SERVICES RESOURCES

Conferences AICPA/AAML National
Conference on Divorce May 13
and 14, 2004 Las Vegas

AICPA National Conference
on Advanced Litigation Services and
Fraud September 26-29, 2004
Phoenix

AICPA National Business
Valuation Conference November 7–9,
2004 Orlando, Florida

Send CPA reports to the attorney.
Any litigation support or special
project report you prepare should state at the
outset that it has been generated for potential
litigation purposes. You should send commissioned
reports directly to the law firm, not to the
client. If possible, discuss the content of
reports only with counsel present and collect all
copies at the conclusion of each meeting; document
such actions.

Segregate report materials or
methodology. If an accounting
report contains information that can be used for
purposes besides legal consultation, you and the
attorney should separate the portions of the
report applicable to business decisions from those
related to the legal consultation. You should
consider using a methodology for preparing an
investigative or litigation-related report to make
it distinct from other work product, particularly
if in the ordinary course of business you generate
reports that look similar. However, the litigation
report must be conventional enough that it doesn’t
invite a challenge for failure to follow
“acceptable” methods, and the methodology for each
relevant transaction must be the same.

DISCRETION AND DUE CARE On behalf of clients, attorneys frequently
hire CPAs as nontestifying experts or consultants.
Federal common law does not recognize an
accountant-client privilege, but under the
Kovel rule, a lawyer may shield a
nontestifying accountant under third-party
privilege. This rule insulates communications and
work product when the attorney hires an expert to
help in the provision of legal services. The
privilege extends only to specific communications,
not facts. Candid communication between a CPA and
client is vital to providing the best possible
service, but there may be pitfalls: If a client’s
loss of a case turns on the inadvertent disclosure
of an electronic communication, the attorney
and/or accountant could be sued for malpractice or
subject to disciplinary proceedings. The ability
to deliver quality services in a manner that
protects privilege depends on keeping sensitive
communications and work product from disclosure or
interception.